Ukraine: The energy impacts

March 5th 2014 | Multiple countries | Oil and gas | Gazprom

Europe does not face a gas crunch, but Russian actions in Ukraine could hasten efforts to shore up EU energy security.

Russia’s intervention in Crimea has sent countless economic indicators hurtling downwards—the Moscow stock market, for instance, and the Russian rouble’s value against the US dollar. Others have shot skywards. Oil prices, ever sensitive to political risk, fall in the latter category: the threat of conflict has escalated. So too do natural-gas prices, the upwards forces on which were compounded by a threat on March 1st by the Russian state gas-export giant, Gazprom, to raise the price it charges Ukraine. Yesterday Russia’s president, Vladimir Putin, confirmed Gazprom will end the discount granted to Ukraine’s now ousted president, Viktor Yanukovych, in December.

The apparent willingness on Russia’s part to use its control over gas supplies as a political tool rings alarm bells throughout Europe. One-half of Russian supplies to the EU, which looks to Russia as a key gas supplier but has sided with Ukraine’s new government, flowed through Ukraine in 2013. Memories have been awakened of episodes in 2006 and 2009 when, amid pricing disputes, Russia cut off supplies to Ukraine at the height of winter, causing European gas prices to spike. But this time, while the threat of military clashes is higher, the energy risks for Europe are not.

Dependent, but less so

Russia supplies a far smaller share of Europe’s gas supplies than used to be the case. In 2013 Gazprom accounted for about 30% of EU supplies, a record high in absolute terms and a 16% increase on 2012 volumes. But Gazprom’s share of EU gas imports has diminished from nearly 50% in 2000 (see chart). Spurred partly by worries about its Russian dependence, Europe has turned in greater measure to liquefied natural gas (LNG), coal and especially renewable energy for electricity generation.

Certainly, EU reliance on Russian gas is still uncomfortably large, particularly among its eastern members. But Europe is more resilient than it would have been even a few years ago in the event of a relatively short break in supplies, provided it lasts only a matter of days or weeks. Given that Russia depends heavily on European gas demand, a longer switch-off than this would be strongly against its interests too.

Not only are Russian supplies less important for Europe than they used to be, but Ukraine’s role as a gas-transit hub is also diminished. Opening the Nord Stream pipeline through the Baltic Sea to Germany in 2011 gave Russia a 55bn-cu-metre/year alternative route into Europe, less vulnerable to disputes. (The Brotherhood pipeline across Ukraine can transport over 100bn cu metres/y.) Spare capacity on Nord Stream and the Yamal pipeline through Poland and Belarus gives Gazprom other ways to get its gas to EU customers.

Heating up

For Europe, moreover, the timing of the current flare-up could have been much worse. A stoppage now would be far less serious than one in early winter. Warmer months are ahead, meaning lower gas demand. First, Europe must cope with March, the last cold month of the winter. But European gas storage facilities are well-stocked: the UK’s, for instance, is filled well above average levels at this time of year (Ukraine’s would reportedly last four months if Russian supplies, which satisfy one-half of Ukrainian gas demand, were cut). After all, EU gas demand has flagged along with the economy. We expect it to grow by under 1% in 2014, as economic activity recovers only mildly and coal remains cheap.

Seen in a larger context, the consequences of the Ukrainian crisis for European gas prices are also less dramatic than they may seem. Prices had fallen appreciably in the months preceding the current rise in tensions. The subsequent rebound, fuelled by fears of war rather than physical supply limits, leaves them well below their previous peak.

What if Russia did turn off the Brotherhood pipeline? One effect would be to drive up LNG prices, already very strong especially in Asia. Cargoes selling for US$18-19 per million British thermal units (mBtu) now could then command more than US$20/mBtu. New LNG projects set to come online in Papua New Guinea and Australia later this year will not help Europe if Russian supplies falter soon. Expected output rises in Norway and the UK in 2014 would help, but are not sure to materialise.

Make no mistake, however: the biggest effect on energy markets of a shutdown of gas exports through Ukraine would be on Europe’s coal demand. As in recent years when gas has been expensive, the EU would burn greater quantities of cheap coal to generate power. Plentiful supplies from the US would help European consumers switch energy sources with relatively little impact on their costs.

Looking to the long term: LNG

On balance, though, the implications of events in Ukraine for European gas supplies are less shocking than the dramatic events on the ground might suggest, even in the event of a limited outage. This is in line with comments yesterday from the EU’s energy commissioner, Guenther Oettinger. "We are not concerned about short-term security of supply [for the EU]," he said, while expressing anxiety about Ukraine’s energy security. But the troubling recent events could nonetheless halt the revival in Gazprom’s exports to Europe and strengthen the urge among utilities there to seek other sources of supply.

Before intervening in Crimea, Mr Putin seems likely to have calculated that Europe relied too heavily on Russian gas to take strong action against him. Taking the long view, he might assume the episode will have little effect on the European market for Russian gas. Yet this logic could possibly prove too sanguine. Although Europe does not currently face a supply crunch, Russia’s actions could help concentrate European minds on further shaking off dependence on Gazprom.

In the long run, the effects of this could be felt in the LNG market. For the EU, LNG imports are the readiest direct substitute for Russian gas. Needless to say, increasing European LNG imports would threaten the interests of Gazprom and Russia.

Certainly, Europe will be constrained in any attempts to buy more LNG by competition for limited supplies with gas-hungry Asia, where shipments fetch higher prices. Still, Russian moves in Ukraine could play into the hands of those in the US who argue it should speed up approvals for LNG export facilities. A US boom in extracting natural gas from shale rock has depressed gas prices there, but policymakers have been slow to sanction LNG shipments. The pace of approvals has lifted in the US, as it has in Canada, but building LNG-export infrastructure is a painstaking process. Indeed, construction has only begun at one of the six facilities approved by the US government so far.

Another dampener is that Canadian and US gas would be destined mainly for Asian markets—also true of supplies from the main LNG-market insurgent, Australia. The prices of cargoes heading to Europe would have to account for outlays on liquefaction and transport. Despite low gas prices across the Atlantic, then, Europe would be unlikely to gain any price advantages from buying North American gas. Still, a better-supplied market should help European utilities if they seek further shipped gas supplies.

If they do so, there will be no shortage of LNG-receiving infrastructure available to them (though the gas grid connecting heavily Russia-reliant East and Central Europe would need further investment). Many European LNG import hubs are under-used, as gas shipments have lost out to cheap coal and piped gas imports. This is not stopping some countries, conscious of their exposure to Russia, from adding capacity. Work on a new terminal in Poland designed to ship in gas from Qatar, the top LNG exporter, is due to be completed by end-2014. Estonia and Finland, both EU member states and Gazprom-dependent neighbours of Russia, last week resolved a dispute over which should build a new LNG terminal. In the end, they decided to build one each.

Gazprom wants to lift its share of European gas supplies even further, but already faces stiff regulatory headwinds from the European Commission; Russian actions in Crimea have hardly helped its cause. Europe still needs Russia’s gas, but is now more likely to step up the search for alternatives. Among Mr Putin’s few Western admirers may be LNG exporters with their eyes on long-term profits.